1.7. This chapter has focused on the effect of taxes. Let’s consider the effect of subsidies, which also generate deadweight loss. A subsidy creates a gap between the price received by sellers and the price paid by buyers.

a. Complete the table using the letters from the above diagram. The government “revenue” is negative, because a subsidy requires a payment by the government.

b. Based on this table, what is the deadweight loss of the subsidy? (Hint: this is the difference in social surplus between the two columns.)

c. Describe why a subsidy creates deadweight loss. Try to use your answer to the previous part as a guide.

No With Subsidy Subsidy Consumer Surplus Producer Surplus Government

“Revenue”

Social (Total)

Surplus 0

−(B+C+D+E+G)